In January of 2018, the FTC released business practice guidance to multi-level marketing companies. As part of this guidance, the FTC described illegal mlm compensation structures. “Pyramid scheme” is another term for this type of illegal MLM.
The “unlawful MLM structure” description comes from court decision from the FTC’s case against Koscot:
“Characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting the other participants into the program rewards which are unrelated to the sale of the product to ultimate users.”IN re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975).
Illegal or Legal?
In order to be lawful, MLMs compensation plans should be based on actual sales. Here are some things to look for to tell if a compensation plan may be unfair, deceptive, and ultimately unlawful:
- Compensation based on mere wholesale purchases
- Compensation based on other payments by participants
- Participants buying products that are not resold
- Incentivizing/encouraging participants to purchase for reasons besides satisfying personal and customer demands (ex: opportunity to advance)
Therefore, consider any of the above serious red flags.
Myth: Pyramid schemes don’t sell products
Just because a company sells products doesn’t mean that they are legal. Some MLM companies that sell products are illegal and have been ruled pyramid schemes. The FTC has sued and won cases against MLMs selling products and found them to be illegal schemes.
Many MLMs encourage joining as a distributor in order to buy products at a discount. It is sometimes legitimate to purchase products at wholesale for personal use. In contrast, when the actual demand for these products was the minority of sales, the FTC has prosecuted and won.
What to look out for
- Commissions on wholesale purchases (not retail sales)
- Customers can’t buy directly from the company (only from participant’s inventory)
- Customers must sign up as participants in the business (they can’t just be customers)
The guidance gives suggestions for how companies have shown they followed the FTC act (see #8 in the FTC Guidance). Ultimately, this means showing evidence of sales of products to retail customers. Examples in the guidance include:
- Customers signing up as customers
- Customers buying directly from the company (participants simply refer or sign up customers)
- Commissions on retail sales rather than wholesale purchases
Why is the FTC involved?
The FTC has a goal to protect consumers. The FTC is supposed to go after MLMs that have illegal compensation structures. These MLMs harm consumers. The FTC guidance explains:
“Where such an unlawful compensation structure exists, a participant is unlikely to be able to earn money or recover his or her costs through selling product to the public. In such circumstances, participants will often attempt to recruit new participants who will buy product, and pressure existing recruits to buy product, with little concern for consumer demand. Where an MLM has a compensation structure in which participants’ purchases are driven by the aspiration to earn compensation based on other participants’ purchases rather than demand by ultimate users, a substantial percentage of participants will lose money.”2018 Business Guidance Concerning Multi-level Marketing
This means the money to pay older participants comes from the newer recruits and not from non-participant product buyers. Most of the participants will lose money, only the oldest (highest in the uplines) will make money.
It is dangerous to get involved with a company that has red flag policies. Remember that just because a company isn’t doing something illegal doesn’t mean the company is a good business opportunity.
Avoid buying from or selling products for companies which engage in bad practices. If it seems like a company is following FTC guidance, next ask questions to find out if it is a good business opportunity.
This is just for informational purposes and should not be considered legal advice. Be sure to check out the source material yourself, it’s from the FTC. Contact us with any feedback or corrections.